About GE and the 52-week Low Rule In A Bull Market

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GE has just lost its spot on the Dow 30. Walgreens will replace it. This should not come as a big surprise. Its stock has been in a disarray for quite some time. It is down about 60% for the past 18 months.

You would not believe how many people told me they were buying GE at 25, 20, 18, and 15 because “it has become very cheap and it will come eventually back”. Maybe, it will recover to all-time highs one day. Maybe, it will take many years to do so and you will get tired of waiting.

Not all individual stocks recover from a big drawdown. Many remain dead money for decades to come. There is a big difference between individual stocks and stock indexes.

Indexes usually come back because they are diversified and they cut the losers (remove stocks which market cap has fallen below a threshold level) and add potential winners (add stocks which market cap has risen above certain threshold level). The current minimum threshold for the S&P 500 is $6.1 Billion.

The most popular stock indexes in the U.S. are basically long-term trend following systems in disguise. I sometimes joke with passive investors (indexers) that they are actually trend followers who don’t want to pick stocks.

Buying 52-week lows in a bear market is understandable if you are a value investor. Most stocks take a big hit during market corrections and the good is thrown out with the bad.

Buying stocks making 52-week lows in a raging bull market is a completely different story and it often doesn’t end well. If a stock keeps plunging while the rest of the market is advancing there’s is usually something very wrong with it and it is likely to continue lower. You can save yourself a lof headaches if you ignore the 52-week low list during bull markets.

Most people will be better off waiting for a beaten-up stock to build a new base and break out to new 52-week highs before they enter. A new 52-week high in a crushed stock might still mean 50% below its all-time highs.

When you buy a new 52-week high in a heavily neglected stock, you achieve two things: you have momentum on your side and you have plenty of people who don’t believe in the stock, which is good because those same people are a future source of demand.

Why Momentum Investing Is A Contrarian Approach

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The two biggest errors in bull markets are usually errors of omission. Not buying a stock because it is up too much too fast or not buying a stock because you sold it at a lower price recently.

If you bought something at 10 and sold it at 14, the odds are that you are not going to buy it back at 20. Even if the new setup looks incredible, it will be like chasing to most. This is why momentum investing is a contrarian approach and it continues to work. It seems easy only in hindsight, but it is never so when you have to apply it in real time.

People need time to adjust to new prices. When a stock goes from 40 to 160, it seems extremely expensive to everyone. It takes spending a considerable amount of time in that new price range, for people’s mental model to change. This is why many momentum stocks build new bases after a considerable recent run.

The typical momentum stock goes through 3 distinct stages:
1. Price leads – expectations for a brighter future attract buyers and a company price appreciates very quickly mainly because of a P/E expansion. The market is willing to pay a higher price for the expected earnings. FOMO (fear of missing out), short squeezes, and the overall market sentiment also have a big impact. An optimistic market might be willing to pay several times higher price than a pessimistic market for the same earnings growth.
2. Price spends some time in a range while earnings growth catches up with the market expectations. The market made a bet for a brighter future in stage one and now the company needs to prove the market right by delivering strong earnings growth. If a company fails to meet the market’s high expectations, its stock might quickly decline 50% or more.
3. Price growth and earnings growth go hand in hand.

NVDA might be a typical example. It had a huge run in 2016-2017. It seemed expensive all the way from 40 to 200. Then, it spent 6 months in a range and now it is setting up again near its all-time highs. $300 is very possible scenario by the end of 2018.

Disclaimer: everything on this website is for informational and educational purposes only. The ideas presented are not recommendations to buy or sell stocks. The material presented here might not take into account your specific investment objectives. I may or I may not own some of the securities mentioned. Consult your investment advisor before acting on any of the information provided here.

About that Silly “There Are No Good Trading Books” Argument

Traders who are considered successful are often asked the question – “What Trading books do you recommend?”. I am often stunned to hear some of them saying that there are no good trading books.

The reasoning that there are no useful trading books is ridiculous. It comes from people who don’t have the patience, the time, or the skills to create a good book – it takes hundreds of hours of dedicated deep work. The difference between writing and reading a book is the difference between growing and eating an apple.

“If it is that good why are you sharing it” is the silliest argument. Writing a book about any subject makes you think long and deeply about it. It encourages and requires you to experiment, read, compare, study, write. At the end of the process, you learn a lot more about yourself and about the subject.

The statement that “no trader will share a working method” doesn’t hold water. It is one thing to read about a subject and completely different to be able to practice it properly. Watching a Bruce Lee movie doesn’t make you a martial arts expert. Knowing what it takes to get in a great shape (proper diet and exercise), doesn’t mean that it is easy to achieve it.

If you are too lazy to learn from other people’s perspectives, nothing is going to change your mind.

Ten Lessons from Michael Batnick’s Book ‘Big Mistakes’

I ran a search on Google for the expression “mistakes are”. The results:

In his first book, Michael Batnick outlines the big investing and trading mistakes of some of the most successful investors and brightest minds that are known to humankind. Most mistakes revolve around the same themes:
– being overleveraged and building too big positions in assets that were illiquid or suddenly became illiquid;
– venturing outside of expert zone when having to manage a much bigger amount of capital;
– overconfidence and hubris;
– normal mistakes that cannot really be prevented; they are part of the investing process;
– fear of missing out.

I enjoyed reading Michael’s book . It is not a how-to book. It is an interesting dive into market history and psychology. Here are some of the more interesting insights I found:

1. Leverage made Livermore his fortune, leverage destroyed him. He knew everything one can possibly know about market psychology and price action but it seems he never learned how to control risk – it was a constant all or nothing betting for him. No wonder he went broke 4 times.

2. Ben Graham understood that no approach works all the time. There are time and place for everything. Markets evolve and some concepts stop working. A margin of safety doesn’t matter during periods of forced liquidation, especially when you are leveraged to the hill.

3. “A high IQ guarantees you nothing! This is one of the hardest things for newer investors to come to grips with, that markets don’t compensate you just for being smart.” and “Intelligence in investing is not absolute; it’s relative. In other words, it doesn’t just matter how smart you are, it matters how smart your competition is.”

4. “Putting too much money into something you don’t fully understand is a good way to lose a lot of money. But what’s more damaging than losing money is the psychological scar tissue that remains after the money vanishes.”

5. “Once something belongs to us, objective thinking flies out the window.”

6. “Professional win points. Amateurs lose points”, therefore professionals should play to win and amateurs should play not to lose (try to make fewer mistakes).

7. “Bad things tend to happen when we compare our portfolios with others, especially if they possess a lesser IQ and extracted a higher return.”

8. On the dangers on concentrated bets: “A single stock leveled one of the most successful funds of all time, you should think twice before putting yourself in the same type of situation.”

9. “The most disciplined investors are intimately aware of how they’ll behave in different market environments, so they hold a portfolio that is suited to their personality. They don’t kill themselves trying to build a perfect portfolio because they know that it doesn’t exist.”

10. “The average intra‐year decline for US stocks is 14%, so a little wind in the bushes is to be expected.2 But saber‐toothed tigers, or backbreaking bear markets, are few and far between. Corrections occur all the time, but rarely do they turn into something worse, so selling every time stocks fall a little and waiting for the dust to settle is a great way to buy high and sell low.”

Source: Batnick, Michael. Big Mistakes: The Best Investors and Their Worst Investments (Bloomberg). Wiley. Kindle Edition.

Two Stocks That Surprised Everyone This Year

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FOSL which is up 170% year-to-date which makes it the best-performing S&P 500 stock so far. Who would’ve thought that a watch-maker would be one of the price leaders in 2018? Probably, no one. This is one of the reasons why it is happening.

The best-performing stocks in any given year are usually the ones that surprise the most which mean that they are either:

A) High-growth stocks that keep growing much faster than most analysts expect. They have established a powerful price momentum and no one believes they can possibly go any higher. NFLX is a good recent example.

Or

B) They come from an industry with extremely low expectations and high short interest. Extremely low expectations are easier to beat by a wide margin and high short interest is a potential fuel for higher prices because short sellers eventually will cover their bets (the question is if they will do it voluntarily when a stock sells off or involuntarily when a stock rallies and their bets are squeezed higher). FOSL and MOV are good recent examples.

Low expectations + New 52-week High can be a powerful combination.

Think about it. What’s your most likely reaction when you see a stock from low-expectations industry make new 52-week highs? You are very likely to dismiss the price action and think that the market must have gone crazy.

All trends need skeptics and doubters otherwise there would not be anyone left to buy.

When I highlighted MOV on Momentum Monday ten days ago, Howard’s reaction was: “Don’t they make watches? I am not interested in that stock”. His reaction made me smile. Almost every time when I highlight a great technical setup that Howard doesn’t like for fundamental reasons, the stock in question ends up making a significant move higher.

Today, MOV broke out to new 52-week highs after beating earnings estimates by 240%!

I don’t know what the future of FOSL and MOV is. I don’t use their products. Maybe, this year’s rally is just a temporary blip and the gradual adoption of smartwatches like Apple will end up being an extinction process for Fossil and Movado. What I know is that we should be paying attention to stocks from unpopular industries making new 52-week highs. Sometimes the market as a whole is smarter than its individual parts.